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What you should do while interest rates are low

Filed under Blogs

July 26, 2017

Official Reserve Bank interest rates in Australia have been on hold at a record low of 1.5% for 11 months in July 2017, although some lenders have begun to make out-of-cycle interest increases to both fixed and variable mortgage products.

Stop paying interest only

While interest only loans are considered primarily as being used for investment purchases, in fact 40% of all interest only loans are for owner occupied homes.

There’s been changes made to investor loans recently by the Australian Prudential Regulation Authority (APRA) to reduce the percentage of interest only loans that banks can administer to customers to 30% of the total number of mortgages.

If you apply for a home loan now, you’re less likely to be offered an interest only loan.

But what if you already have an interest only loan? With interest rates now at record lows, it’s an ideal moment to start to tackle the principle of your mortgage before rates, and your mortgage repayments, inevitably increase.

In fact, by switching to a principal and interest loan now, it’s likely that you’ll get a lower interest rate, with comparison site Canstar figures putting average variable interest rates for a principal and interest loan at 4.46%, compared to 4.54% for interest only payments.

Three-year fixed rates sit at an average of 4.33% for principal and interest, and 4.4% for interest only.

Why should you do this? If you’ve got an interest only loan to keep your repayments down, it might be time to re-evaluate this strategy in light of your long term goals.

The numbers speak for themselves: keeping your repayments low can cost you in the long term.

For a $300 000 loan over 30 years, principal and interest payments will be around $1 500 per month, where interest-only payments will be less, around $1,100 each month.

The catch is that if you continue to make interest only payments, the difference in the total cost of the loan will be around $22, 000 - making your home a lot more expensive than you’d planned.

Make payments more often

Making your mortgage payments when you’re paid not only ensures that this money comes out of your account first, it can also save you in the interest that you pay, and how quickly you’ll own your home. In just one year, you could pay an extra month’s worth of repayments.

Case Study:

Scenario One: Monthly Repayments

Considering a $300 000 loan (the size of a first home loan for many Australians) with a 4.46% interest rate and monthly payments of $1 512, paying monthly, you’ll pay back $18 144 at the end of one year.

Scenario Two: Fortnightly Repayments

Making fortnightly repayments of $756, you’ll end up paying back $19 656 in one year. If you do this for the life of the mortgage, you will pay back the entire loan early by as much as 4 years, and save $41 290 in interest - quite a lot of money for a small change in your habits.

Make extra repayments

When interest rates do rise, you’ll have to pay more towards your mortgage. By adding an extra $20-50 per week now, you can not only adjust more slowly to a larger repayment, you will also reduce the amount that you owe, saving on interest.

Paying an extra $50 per week could save you around $58 000 and 6 years on the life of your loan.

Of course, before planning to make extra payments you should check the cap on extra payments if you have a fixed rate loan, and pay up to the maximum allowed by the lender.

Paying more now you’ll be making progress on your debt much faster than when rates move back towards the historical average around 7%, so make the most of the opportunity to own your home sooner. Plus any extra repayments above the minimum that you make will go directly towards the principle of the loan.

You can calculate the difference that paying a lump sum or a regular extra amount will make to your whole home loan using our extra repayments calculator.

Get smart about negative gearing

With low interest rates locked in for now, it might be tempting to borrow more than you can afford for your next investment. When you’re assessing how much you can spare to invest, allow yourself a buffer of 10% in case the situation changes.

Whether it’s an increase in interest rates or changes to legislation around negative gearing, the status quo can’t be expected to hold indefinitely. Positive gearing any new investments will ensure a stable cash flow and protect you from adverse changes to the current taxation model.

Having a diverse investment portfolio will also improve your long term financial stability, rather than putting all your money into one investment category.

Saving a first home deposit - increase your yield.

If you are a first home buyer pulling together the deposit you’ll need to take the leap into the property market, and you’ve still got a few years before you’ll have your target amount, consider, putting your savings into staggered term deposit accounts.

Term deposits generally start at 3-6 months, and you can choose to lock away savings and build interest over 12-14 months.

When you’re saving, low interest rates aren’t ideal, though they do mean that you’ll enter the property market sooner due to the low cost of borrowing.

Spreading your savings across a few short, medium and long term accounts means your funds aren’t all at call or maturing within a short time period, and you maximise your savings potential.

Use an offset account

An offset account is a savings account that’s linked to your mortgage. The funds in this account will reduce the interest that’s charged on your loan. This account makes a difference as home loan interest is calculated daily based on the loan balance.

With $10, 000 in an offset account, when you owe $290 000 on your mortgage, you’ll only pay interest on $280 000.

Any action you take now to decrease the amount remaining on your home loan will help to provide a buffer to minimise future interest rate rises.

But what if interest rates rise sooner than anticipated and you’re caught out?

What to do if rates rise unexpectedly

When interest rates rise, it means your mortgage repayments will increase. The effect is immediate on the part of your loan that’s calculated at the variable rate, and will affect any fixed repayments once your fixed loan term ends.

It will pay to check in with a mortgage broker to ensure that you’re still with the best loan product. It’s possible there could be a new lender or loan product that will have lower repayments after a Reserve Bank rate rise, so it’s worth at least getting the information.

The next thing to focus on is ways to reduce expenses and increase income to meet higher repayments. This means reassessing your outgoings and creating a new plan for your finances, maybe renting a room or hosting for AirBNB. Once you get started there are lots of creative ways you can boost your income, and every bit helps.

Rob Murdoch

Rob's been in the banking industry for 11 years. For the last 6 years, he's been specifically providing premium mortgage brokering services. He uses his in depth product knowledge to connect clients with the right product at the lowest rate every time.

Rob holds a Diploma in Finance and Mortgage Broking Management, and is an individual member of the Finance Brokers Association of Australia Ltd. Before joining Positive Home Loans in 2013, he gained valuable experience with Westpac, Bank of Queensland and Mortgage Choice.